During the Great Recession, 25 of 33 OECD countries have used some version of short-time work, a form of publicly subsidised working-time reductions. This column argues that despite its popularity, knowledge of the macroeconomic effects of this measure is limited. Using Germany as a case study, it’s clear that the existence of a short-time work system stabilises the economy and reduces job losses by roughly 20% during a recession. However, short-time work is a lot less effective for Anglo-Saxon labour markets.

Short-time work means that the government subsidises the reduction of the working time of an employee to prevent firing. Many countries allow a firm to use this instrument when the demand for its products is lower than its production potential. Since more firms face a shortfall of demand in recessions, there is a rule-based component of short-time work. This is similar to the income-tax system where the tax bill drops automatically with lower income (without modifying the tax code). In addition, policymakers facilitate the access to short-time work in recessions. Thus, there is also a discretionary component of short-time work. The equivalent in the tax system would be reductions of the tax rates in recessions.

To quantify the effects of the rule-based and the discretionary component, we evaluate the case of Germany using its rich microeconomic and macroeconomic data together with a macroeconomic model of the labour market as a case study (Balleer et al. 2013). Since all firms in Germany are subject to the same rules, we can use the cross-sectional dispersion of the use of short-time work and output over time to estimate the automatic reaction of short-time work to changes in output. We then use this result for two purposes:

First, to disentangle the rule-based and discretionary component of short-time work in the vector autoregression.

Second, to parameterise our macroeconomic model in order to run a counterfactual analysis of an economy with and without short-time work and, hence, to quantify the automatic stabilisation effects of short-time work.

We are the first to make the distinction between the discretionary and rule-based component (for a pure discretionary analysis, see e.g. Faia et al. 2013) that turns out to be very important in our German case study.

No effects on unemployment of discretionary short-time work policy

Our time series estimations deliver surprising results (see Figure 1). Discretionary short-time work interventions do not deliver a statistically significant effect on unemployment. This suggests that policymakers’ actions to save additional jobs in recession seem to be completely ineffective in Germany. Interestingly, our labour-market model provides a rationale for this result. Firms that are on the margin between firing and not firing can already use short-time work due to the existence of the institution (i.e. the rule-based component). Since these firms already use short-time work they do not gain from easier access to short-time work. Easier access will induce additional firms to use short-time work, but these are firms that would not have fired a worker even without short-time work. In that way an extension of short-time work during a recession subsidises some additional firms, without any impact on firing.

Figure 1. Estimated impulse responses to a short-time work policy shock. Quarterly responses to a positive one standard deviation shock. Confidence bands are 90% bootstrapped bands. The structural vector autoregression is estimated with German data on GDP growth, short-time work as a percentage of employment and the unemployment rate from 1993Q1 to 2010Q4

Strong automatic stabilisation of short-time work

While our paper suggests that the benefits of discretionary policy interventions are limited, our model simulations document that short-time work is a very powerful economic stabiliser. German short-time work reduces unemployment fluctuations by 21% and output fluctuations by roughly 4% (see Table 1). This is very substantial given that the costs of short-time work account for just 0.03% of GDP on average. As a comparison: The income tax is about 10% of GDP and the literature estimates stabilisation effects to be in between 6% and 30% of GDP (see in’t Veld et al. 2012).

To obtain a better feeling for the magnitude of stabilisation, we simulate a Great Recession scenario in our model. We impose a macroeconomic shock such that it generates the increase of unemployment of 4.8 percentage points, i.e. the effect that could be expected with such a severe recession. Our counterfactual analysis predicts that the rule-based component of short-time work has saved 466,000 jobs in the Great Recession in Germany. Thus, short-time work was an important job-saver in the Great Recession, but can certainly not explain the entire German labour-market miracle (roughly 7% GDP drop without substantial employment losses).

A further interesting aspect of our model analysis is that short-time work is a more effective stabiliser in countries where firing is more costly for a firm (compare Table 1). When it is very costly to fire workers, firms have a strong incentive to use the hours adjustment (subsidised by the short-time work system) instead of firing. This explains why our simulations suggest that short-time work stabilises employment fluctuations by only 6.5% if firing costs are zero, instead of by 21% as in our baseline. This is well in line with the observation that short-time work is used more in countries with substantial firing costs (Cahuc and Carcillo 2011), i.e. policymakers in these countries seem to be aware of the fact that this measure is more beneficial with their labour-market institutions. Due to additional institutional differences in the US, such as individual instead of collective bargaining, the stabilisation effects would even be smaller in the US economy than in the case with zero firing cost (but otherwise German institutions) case in Table 1 (for numbers and a discussion see Balleer et al. 2013).

Conclusions

Does our analysis mean that policymakers can use short-time work only passively, by letting the constant rule-based component do its job? The answer is a clear ‘no’. However, if they want to use short-time work as a more active stabiliser, they should incorporate this into the rule set. Policymakers could for example decide ex ante that employer sided subsidies or the maximum duration of short-time work automatically increase in heavy recessions. If done so, firms’ will take this into account in their forward-looking hiring and firing decisions and short-time work may even stabilise beyond the effects described in our paper. However, we leave a detailed cost (or optimality) analysis of such countercyclical rule-based policies for future research.

Authors' note: The authors would like to thank the Fritz Thyssen Stiftung for support of this research project.